ICICI Bank: Will the valuation discount vis-a-vis Axis Bank narrow?

ICICI Bank has under-performed both Axis Bank and the S&P BSE Sensex in 2015 so far. As compared to gains of 13.3 per cent in Axis scrip and 3.4 per cent in Sensex, the ICICI scrip has corrected about six per cent this year. Consequently, ICICI Bank now trades at a 16 per cent discount to Axis on a price/book value basis, higher than its historical valuation discount of about 10-11 per cent vis-à-vis Axis. ICICI Bank trades at 2.2 times FY16 estimated book value versus Axis' 2.6 times. Analysts, however, believe this valuation discount is unjustified and should reduce over time.

Vaibhav Agrawal, VP Research – Banking, Angel Broking says, "ICICI Bank's asset quality trends and management commentary around asset quality will be key in the near term. In the medium term though we expect the valuation gap between Axis and ICICI to narrow as these pressures ease."

In the December 2014 quarter, while Axis witnessed improvement in asset quality, ICICI disappointed. While not ruling out the possibility of near-term disappointment, analysts believe these banks will show a gradual improvement in the asset quality in the medium term. As of December 2014, annualised slippage ratio stood at 1.2 per cent for Axis and 2.7 per cent for ICICI Bank and is a key reason for rise in the valuation discount.

And that's despite both banks are largely similar in terms of loan mix and have high exposure to infrastructure.

"There isn’t much difference in the loan mix or composition of Axis and ICICI (in fact, Axis has a higher SME exposure than ICICI) and hence we believe, while there could be some temporary differences, eventually the gap in their slippage ratio should normalise," says Suresh Ganapathy, Financials analyst at Macquarie Capital.

Both the banks though are highly levered to improvement in economic growth and infrastructure reforms in particular. Also, Axis scrip has been factoring in the positives of resilient financial performance, believe analysts. Despite having a higher loan book - 44 per cent higher than Axis at Rs 3,75,345 crore as on 31st December 2014, ICICI Bank is expected to post net profit growth of 19 per cent and 20 per cent in FY16 and FY17, respectively which is quite similar to what street is expecting from Axis.

Going forward, there are a host of triggers for the ICICI scrip. Apart from improving macro growth, steady implementation of infrastructure reforms and falling interest rates, value unlocking via stake sale and/or listing of its Insurance ventures – ICICI Prudential Life Insurance and ICICI Lombard General Insurance is another catalyst for the stock. Given the strong market position and profitability of these businesses, the likelihood of monetising at a good premium to analysts’ current valuations is high.

While asset quality pressures will ease only gradually, analysts are expecting the bank’s return on equity ratio to expand by 160 basis points to about 15.6 per cent in FY16 as compared to 14 per cent in FY14 on the back of strong profit growth. Focus on low-risk retail segment, expectations of higher than industry loan growth as credit growth picks up and strong capital position are key enablers for healthy revenue and profit growth for the bank, believe analysts.

Most analysts polled by Bloomberg this month have a Buy recommendation on ICICI with an average target price of Rs 427, indicating an upside of about 29 per cent from current levels of Rs 332.